What is Pent Up Demand in Economics?
The phenomenon of pent-up demand in economics occurs whenever a period of restricted consumer spending is lifted, with a resulting explosion of demand for all sorts of goods and services that were previously unavailable. The obvious example of this came after the Covid-19 pandemic lockdowns were lifted.
The lockdowns that were imposed on the global economy were, of course, accompanied by huge increases in fiscal spending in most countries. That fiscal excess went towards anything from vaccine research & development, test and trace applications, and payments to households and businesses of various forms in order to replace lost incomes.
This all coalesced to create a very significant build up of pent-up demand which, once unleashed, led to an unsustainable explosion of consumer spending on the high-street in shops, restaurants, bars as well as on travel, hotel accommodation, concerts, sporting events and so on.
While many political leaders around the world, and the heads of their central banks, declared that their economies would simply bounce back from the depths of the pandemic lows, the reality is that the delicate balance between aggregate demand and aggregate supply had been severely disrupted.
The consequences of that disruption started in the form of rising prices i.e. rapidly rising inflation, and at the end of 2022 it looks set to continue with a sharp recession and rising unemployment. In this article I will explain how an unleashing of significant pent-up demand causes problems for an economy.
Understanding Pent-Up Demand
The likely emergence of pent-up demand in the aftermath of the pandemic restrictions was not well anticipated by the majority of economists and political commentators. There are exceptions, but some of the most prominent thinkers, including Lacy Hunt, David Rosenburg, and especially Jim Rickards were all predicting a post-pandemic deflationary recession. They felt that consumers would be scared for their job security, scared for their health, and generally discouraged to spend money for a protracted period after the lifting of restrictions.
Events clearly proved that this sort of thinking was wrong, and a clearer understanding of pent-up demand would have enabled them to predict the reverse situation i.e., rapidly increased spending by consumers and inflation not deflation. The case for deflation has not been entirely refuted however, and there is reason to believe that there will at the least be a significant slowdown in the rate of inflation once the temporary influence of the pent-up demand is exhausted, and spending levels fall back.
The process of pent-demand leading to inflation and back again is explained in my three articles about:
- An Inflationary Output Gap - this occurs whenever an economy produces fewer goods and services than its consumers wish to purchase. It is a normal part of the business cycle and is usually not significant to cause problems. However, if the increase in demand relative to supply is high, it will lead to significant price rises i.e. inflation. That in turn will require the Federal Reserve and the government to coordinate macroeconomic policy in order to bring inflation under control.
- The Bullwhip Effect - this refers to the effect on the supply-chain when demand accelerates, and the way in which it causes suppliers to overreact by increasing output even more (in anticipation of the trend for ever higher spending to continue). When it drops, rather than accelerate further, it leads to a massive build up of unsold inventory which suppliers then respond to by drastically cutting production, laying off workers, and reducing prices.
- Galloping Inflation - a long-run trend towards higher inflation rarely plays out as a straight steadily increasing rate of prices. It is characterized instead by an initial steady growth in the price level that can easily be overlooked, after which its trend becomes very volatile. Unless remedial action is taken, it will progress to galloping inflation, which is characterized by long periods of several months or quarters of falling inflation in between an overall increase. If allowed to deteriorate, it will eventually result in hyperinflation.
Recording Pent-Up Demand
Recording pent-up demand, or measuring its impact on overall spending, is difficult since we cannot distinguish it from regular spending. We can observe that overall spending is accelerated once restrictions on it are lifted, but it remains difficult to distinguish what part of the accelerated spending would have occurred via a natural resumption of regular spending.
It is, however, somewhat of a moot point. What matters is the extent to which it causes the usual metrics to rise/fall i.e. inflation and unemployment, for how long, and to what extent they will reverse once regular spending levels start to resume.